Nobel Laureate Prescott: Higher Taxes Will Further Stagnate Economy

Contrary to popular opinion, U.S. tax rates aren’t low, says Edward Prescott, a Nobel laureate economist at Arizona State University.

“Tax rates are already high, much higher than is commonly understood, and increasing them will likely further depress the economy, especially by affecting the number of hours Americans work,” Prescott and Lee Ohanian, a UCLA economist, write in The Wall Street Journal.

Including all taxes on earnings and consumer spending — federal, state, and local income taxes, Social Security and Medicare, payroll taxes, excise taxes, and state and local sales taxes, the average marginal effective tax rate totals about 40 percent, the duo says.

That means the average marginal effective rate easily exceeds the official top marginal rate of 35 percent.

“Research . . . indicates that raising tax rates further will significantly reduce U.S. economic activity and by implication will increase tax revenues only a little,” the economists say.

That result stems from the fact that “high tax rates — on both labor income and consumption —reduce the incentive to work by making consumption more expensive relative to leisure, for example,” Prescott and Ohanian write.

Work incentives are “particularly depressed when tax revenue is returned to households either as government transfers or transfers-in-kind — such as public schooling, police and fire protection, food stamps, and health care — that substitute for private consumption.”

Higher taxes also put a cramp on entrepreneurs, who are so vital to our economic vitality, the economists say. “Entrepreneurship is much lower in Europe, suggesting that high tax rates and poorly designed regulation discourage new business creation.”